--Interdealer brokers face new regime for trading swaps
--Some see rules favoring futures markets over swap platforms
--Exchange investments pursued as way to cover bases
(Adds comments by executives at industry conference in paragraphs seven, 10 and 20.)
By Katy Burne and Jacob Bunge
Brokers of swaps are fighting for their future.
The firms known for facilitating banks' trades in privately negotiated derivatives are reaching for relevance in response to new rules that may threaten their livelihood in swaps while boosting exchanges that cater to openly traded futures.
Interdealer brokers, in particular, are under pressure from the rules, having invested heavily in technology they believed would win out under the regulatory overhaul. Now, some are re-evaluating their earlier strategies, and some have invested in exchanges that they view as being better positioned.
"For interdealer brokers it's no harm to have an execution venue that can act as a [registered exchange] in the new world, where there might be new [products] or some migration of swaps" onto exchanges, also known as designated contract markets or DCMs, said Niamh Alexander, analyst with Keefe Bruyette & Woods.
ICAP PLC (IAP.LN, IAPLY), the world's largest interdealer broker, acquired PLUS Stock Exchange PLC in June, saying it planned to offer futures on the equities platform. The firm has since renamed the platform the ICAP Securities & Derivatives Exchange, or ISDX, and now the company has "a number of proven and regulatory trading platforms [that] lend themselves" to the new rules, a spokeswoman said.
Tuesday in New York, the Americas branch of the Wholesale Markets Brokers' Association representing the interdealer brokers hosted a conference it dubbed SEFCon III--its third attempt to redefine the role of broker as the regulations take shape.
"Everyone is looking at DCMs because there is clarity" there on the rules, said Nick Solinger, chief marketing officer at Traiana, part of ICAP, at SEFCon III.
Rival broker BGC Partners Inc. (BGCP) earlier this year boosted its investment in ELX Futures LP, a struggling market that offers financial futures, in a deal that gave BGC operational control over the venture.
GFI Group Inc. (GFIG), another interdealer broker, is looking either to buy an exchange or set one up, according to people familiar with the company's thinking.
"You need a choice of execution," said Ron Levi, chief operating officer of GFI Group, also at SEFCon.
All three firms rank among the top five interdealer brokers that have been at the nexus of the $639 trillion global swaps market that dates back three decades. But their share prices have languished since the 2008 financial crisis.
For some, acquiring exchanges or building new ones represents another way they can facilitate trades for clients who are wary of the added cost and complexity associated with trading swaps under the new rules.
Buying a derelict exchange gives the brokers another choice of execution to offer clients, and is easier than waiting six months or more to secure a new license. Competitive pressure from exchanges is also providing impetus.
"It's looking more and more like taking the exchange bet is the way the market is panning out," said Will Rhode, director of fixed-income research at TABB Group, an independent research firm.
Under the 2010 Dodd-Frank law, swaps will have to be traded on open venues for the first time and routed to clearinghouses that guarantee the trades.
Analysts expect exchanges to be winners in the wake of Dodd-Frank because, while the law allows swaps to be traded openly on exchanges or newly created alternatives called swap-execution facilities, many analysts expect futures to be more most cost-effective. Swaps can be traded either on SEFs or exchanges, but futures can only be traded on exchanges.
"Having a futures exchange that is operationally able to meet the needs of our clients in a much more customized fashion than any of the traditional futures exchanges, I think is an extraordinary asset," Howard Lutnick, chief executive of BGC, told analysts on a conference call this month.
Firms that buy or take stakes in exchanges may run into the same problems as established ones, however, so it remains to be seen if any reinvented platforms can gain traction. Global exchanges themselves have attempted mergers in recent years, with mixed success, and only a few regional specialist exchanges remain.
But the combination of delayed regulations for swap-execution facilities and recent moves by big exchanges, including IntercontinentalExchange Inc. (ICE) switching energy swaps to futures in October, is upending the model some brokers believed for two years would be their best hope.
Thomas Farley, senior vice president of financial markets for IntercontinentalExchange Inc., said at SEFCon III he believed any "futurization" of the swaps market would be on a case-by-case basis, not universal.
"To date, we have all concentrated and proceeded with our SEF plans [and] we believed that was our future," said Julian Harding, executive director at a fourth interdealer broker, Tradition Group, part of Compagnie Financiere Tradition (CFT.EB). "But things have certainly come up which makes someone question if SEFs are the most appealing vehicle."
Mr. Harding declined to comment on any approaches to exchanges made by Tradition or other strategic moves, but said the firm was "constantly scrutinizing" what its next move should be. He said if the shift from energy swaps to futures takes hold in other asset classes, "you can be assured SEFs will be...reconsidering everything."
A GFI spokeswoman declined to comment, and spokespeople at the remaining top five broker, Tullett Prebon PLC (TLPR.LN), didn't return requests for comment.
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